For years I’ve heard about the “60/40” traditional portfolio allocation, meaning invest 60% of your portfolio in equities and another 40% in bonds.
This was ideated in the 1950s and popularised by the late John Bogle, the founder of Vanguard Investment Group. This classic allocation comprises a balance of equities to provide capital appreciation and 40 fixed-income securities for stability. The purpose of diversifying across stocks and bonds is to minimize overall portfolio risk. Historically, the price movements of stocks did not tend to impact those of bonds and vice versa, i.e., they were uncorrelated.
However, the correlation between these two asset classes has begun to converge. The problem with 60/40 these days is the 40 allocated to the bonds side. For most of recent history, bonds have been yielding much higher. In fact, bond yields were recently at their lowest points, historically.
After peaking in September 1981, interest rates have consistently fallen, which has helped push up prices for bonds, creating a once-in-a-lifetime bull market and helping fixed income pull its weight in the asset allocation model. Yields fell so low that for 2021, the benchmark 10-year Treasury yield ranged between 1-1.5% p.a., meaning Treasuries had a negative real return after factoring in inflation.
After decades of money printing, inflationary forces are finally forcing the US Federal Reserve to raise interest rates, causing the bond side of the equation to fall in price to match the new higher yields. As a result, the bond side isn’t currently providing the cushion it has in the past, and thanks to duration risk, this has the potential to cause significant volatility and material losses.
Because of these factors, the classic 60/40 may not work in the years ahead.
33/33/33
As the alternative industry becomes increasingly accessible and transparent, the discussion is emerging for a new portfolio allocation strategy: 33/33/33. A back-tested portfolio that is split between stocks, bonds and alternative assets would have historically performed well. J.P. Morgan Asset Management’s “Guide to Alternatives”1 revealed that allocating just 30% to alternatives in your portfolio can substantially increase your annual returns, while simultaneously strengthening portfolio stability and decreasing risk.
Aura Group is a specialist asset manager specializing in alternative investments. Alternative investments such as venture capital, real estate, private equity and private debt are becoming important parts of asset allocation theory.
Institutional investors also continue to increase allocations to alternative investments at the expense of public markets, driven principally by the desire for portfolio outperformance. CEM Benchmarking notes an average allocation to private markets of 18.5 per cent as of 2020, up nearly five percentage points since 20122. Retail investors, for whom access to the alternatives has been historically constrained, are now receiving more attention. Alternative asset managers are launching new products, devising innovative structures, and building out distribution teams to tap into this vast pool of capital.
At Aura Group we are true believers that allocations to alternatives provide inflation hedges and the benefit of diversification (same case for fixed income) along with a low correlation to stocks. Alternative assets however tend to be illiquid so duration and cashflow planning must be considered. It’s important to remember that illiquidity isn’t a measure of risk. Alternative assets provide great exposure for building intergenerational wealth.
1. https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-alternatives/
2. https://russellinvestments.com/us/blog/why-private-markets-investments
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